Nov 25, 2019

Things to Know about Paying for College

As I said previously, college isn’t the real end goal, it’s getting out of college with the ability to go forth and have a happy and productive life.

A big part of that is not having debt upon graduation. Consequently, over the last couple of years, I’ve become obsessed with paying for college. I’ve learned a ton, and I think we’re going to be okay, if our kids do their part and get good grades and build strong resumés so they can get into schools that we can afford.

The thing is, there's so much information out there, and even with as much as I've learned, I feel like I'm never going to know everything and I worry I'll miss something important. That said, I want to share what I've learned in the hopes that it will help you figure out your family's path on this journey. Just keep in mind that I'm not an expert.

Things to Know About Paying for College

It's never too early or too late to start saving for college. I like the target funds in 529 accounts, since they manage the investment risk for you, and 529 accounts have some tax advantages (see below). If your child is already in high school, I recently heard one expert say that it's not too late - if you can set aside some money and leave it there until the last year of college, that's still four to eight years that the money is growing.

There are many ways to stash money away for college. 529 and Coverdell Education Savings Accounts are tax-advantaged plans for saving for college. In a nutshell, you contribute after-tax money to the accounts, and they grow tax-free. (After-tax money just means money you've already paid income tax on.) As long as you use the money to pay for qualified education expenses (like tuition, books, and room and board), you never have to pay income tax on the earnings. Some states give state income tax breaks on their 529 accounts; unfortunately, California isn't one of them.

Income earned via certain U.S. savings bonds is also tax-free when used for qualified education expenses. Certain withdrawals from IRAs accounts may also be made tax and/or penalty-free if used to pay for qualified education expenses. And of course, you can always save money in a regular savings account, although you'll miss out on the tax savings if you go this route.

Most families get some financial aid. That's right, the vast majorities of families don't pay the "sticker price" for college. But financial "aid" includes many different forms.

The "sticker price" for a college is known as the "cost of attendance" (COA) and generally includes tuition, fees, books, room and board, transportation, and personal expenses. Some of these costs are inflexible, like tuition. But you have some flexibility with costs such as transportation - if you live close to a school, the transportation costs may fall below the estimated amount, but if your child has to fly across the country, your costs might be higher than the estimate.

Don't forget to file the FAFSA. If you went to college, you might remember the FAFSA, or the Free Application for Federal Student Aid. You input data like your income and savings, then the information is sent to the schools you list on the application, and each school makes its own determination as to what financial aid package it will offer your student. Even if you don’t qualify for need-based aid because your income is too high, many schools won’t award merit-based aid without a FAFSA on file, so everyone should submit the FAFSA.

After you file the FAFSA, you'll find out your "Expected Family Contribution" (EFC), which is the amount the federal government determines you can afford to pay for college. Be prepared - it may shock and upset you with how high it is. I’ve heard some low-income folks have an EFC under $100. But I’ve also heard people say their EFC was more than half of their family’s annual income.

There are lots of EFC calculators online if you're not at the point of filing the FAFSA. They may not be entirely accurate, but they should give you a ballpark idea of what your EFC will be. Your EFC shouldn't change based on how many children you have in college. For purposes of calculating financial aid at each school, it basically gets divided equally amongst the kids.

Your child should have as few assets as possible. For purposes of the FAFSA, assets held by parents are assessed at a lower rate than assets owned by a dependent child (5.64% versus 20%). If your child has money in a UTMA or UGMA account, do something to get the money out of their name and into your name. Note that you can’t simply transfer the money from their account to yours, since legally it's theirs and has to be used for their benefit. Consider rolling the funds into a custodial 529 account, which is like any other 529 account, except that it can't be transferred to another family member if your child doesn't use the funds for college. (Even if it's in their name, it gets assessed like a parent-owned asset.)

Make sure you understand your own assets. The FAFSA doesn’t consider your home equity to be an asset. But some private schools require a second financial aid application called the CSS (College Scholarship Service) Profile, which asks for a lot more information and takes your home equity into account in evaluating your ability to pay.

Neither the FAFSA nor the CSS Profile considers your retirement investments (such as your 401(k)) as an asset that can be used to pay for college. However, their calculations will take into account your retirement contributions (i.e., they assume that you can use those funds to pay for college instead of saving for retirement).

If you have a lot of money stashed away in non-retirement savings, consider spending it sooner rather than later. Don't spend foolishly, but if you've been saving money for a new car or a kitchen remodel, spend the money before you file the FAFSA, since it asks for current account balances.

"Financial need" is the difference between the COA and your EFC. Some schools meet 100% of financial need, and some don't.

There are many types of financial "aid." Financial aid can include need-based scholarships and merit-based scholarships, which don't need to be paid back. The major difference is that you don't have to have a financial need to get a merit-based scholarship (schools may consider grades, test scores, special talents, and more in awarding merit scholarships). Financial aid can also include work-study (i.e., the student earns money by working at an on-campus job) and loans (federal and private).

Loans are considered a form of financial aid. In case you missed it above, I want to highlight that loans are considered a form of financial aid. So if your financial need at a school is $10,000, the only "aid" you might get is the ability to take out $10,000 in loans.

Be cautious of student loans. The total student loan debt is now over $1.5 TRILLION. Make sure you and your student know the monthly payment you are contemplating taking on. For example, the current interest rate on an undergraduate Stafford loan is 4.529%. If you graduate with $100,000 in debt and choose a 30-year term (assuming you’re given the option), your monthly payment will be over $500 – and you’ll be paying it off for as long as most people pay for a mortgage. If the loan term is just 10 years, your monthly payment will be over $1,000. Your child would have to earn an impressive annual salary to make their student loan payment and pay for living expenses. No wonder so many adult children end up living with their parents!

It’s never too early or too late to look for private scholarships. Some students are more motivated than others, but there are scholarships for just about every age (even four-year-olds and those already in college) and every niche.

Divorce, separation, and remarriage can substantially complicate matters. If the adults involved don’t have a clear understanding of what each person/family is going to contribute, it might be best to hire a professional.

Speaking of professionals, be sure to hire an expert in this field. If you're going to hire a professional, make sure you find someone with experience and/or a specialty in educational finance. "Regular" accountants and CPAs may not know all that much about paying for higher education. And as with all financial experts, make sure you know how they're getting paid - a fee-only professional is usually a better choice, because they don't get paid for recommending or selling specific investment vehicles.

I covered a lot of ground, but there's also a lot I didn't cover. Let me know if there's something you want to know more about, and I'll do my best!

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